In a Mortgage-Crisis Settlement, Did a Bank Get Off Easy?

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Neil M. Barofsky in 2010 while serving as the special inspector general for the Troubled Asset Relief Program. Mr. Barofsky is overseeing the compliance of Credit Suisse with a settlement reached with the Justice Department.CreditCreditBrendan Smialowski/Getty Images

In January, prosecutors concluded one of the last multibillion-dollar settlements related to the 2008 mortgage collapse. The deal, with Credit Suisse, required the bank to pay $2.48 billion to settle allegations that its securities unit had misled buyers of home-loan bundles it had sold between 2005 and 2007.

Credit Suisse also agreed to provide $2.8 billion worth of financial relief to troubled borrowers under the settlement by forgiving or modifying mortgages and helping to finance affordable housing projects across the country.

When they announced the $5.28 billion deal, prosecutors cited it as evidence that the United States government can and will ride herd on large financial institutions if they engage in misconduct.

“Today’s settlement underscores that the Department of Justice will hold accountable the institutions responsible for the financial crisis of 2008,” said Loretta E. Lynch, the attorney general at the time.

A little more than six months later, it’s worth asking: How tough, really, was the settlement on Credit Suisse?

An answer to that question emerges in a new report compiled by the independent monitor hired to scrutinize how Credit Suisse was living up to the terms of the deal. Put simply, some of the settlement’s terms — those involving consumer assistance — were easier on Credit Suisse than aggrieved investors and borrowers may have wanted.

The settlement terms relating to consumer relief are complex. They allow the bank to earn credit toward the $2.8 billion in consumer help by modifying troubled borrowers’ loans. How much credit is earned by the bank depends upon the types of modifications it gives to borrowers.

One of the monitor’s tasks is to ensure that Credit Suisse receives only the credit that it has truly earned under the deal. This is no small task. Under previous settlements, for example, some banks received credit for forgiving loans that had already been discharged in bankruptcy.

Neil M. Barofsky, a partner at Jenner & Block, is the Credit Suisse monitor. You might recall Mr. Barofsky from his stint as the first special inspector general for the Troubled Asset Relief Program, which administered assistance to beleaguered banks, homeowners and other entities after the 2008 crisis.

Mr. Barofsky declined to comment on the report, which looks at the first six months of the bank’s loan modification and forgiveness efforts. (A later report will focus on the bank’s financing of affordable housing.)

Nicole Sharp, a Credit Suisse spokeswoman, said in a statement, “As the report highlights, Credit Suisse has taken a number of positive steps since our settlement with the Department of Justice.” She said the bank was moving “to put this legacy matter behind it, while also protecting the interests of its clients, employees and other stakeholders.”

So far, Credit Suisse is working diligently on the consumer relief aspect of the settlement, the report said. It is meeting the deal’s requirements through its loan servicing unit, Select Portfolio Servicing, or SPS. There is no doubt that the bank’s efforts are helping distressed borrowers and will continue to.

Nevertheless, a close reading of the 118-page analysis does raise questions about just how tough this settlement really was. Indeed, the report highlights the significant benefits Credit Suisse received under provisions in a deal that prosecutors said would hold the bank accountable.

For example, Credit Suisse can earn consumer relief credit for actions it would likely have taken anyway, the report noted. More troubling, most of the loans Select Portfolio Servicing will modify — and Credit Suisse will receive credit for — are owned by others. They are investors in mortgage-backed securities or rival financial institutions. “Nearly all of the loan modifications SPS will complete for credit will be performed on loans owned by third parties, and to the extent those modifications result in any loss, it will be borne by the owner of the loan, and not Credit Suisse,” the report noted.

Allowing the bank to forgive loans it does not own, which the Credit Suisse settlement specifically does, puts the bank in a position to benefit from others’ losses.

Here are the details. According to the analysis, Credit Suisse’s current focus is to modify troubled loans, allowing borrowers to pay less than is currently owed on their mortgages or to defer payments on a portion of the principal outstanding. Both arrangements help borrowers stay in their homes and avoid foreclosure. That was a primary goal of the settlement, and it was a good one.

The bank has agreed to try to satisfy its consumer relief obligation by Dec. 31, 2020.

When Credit Suisse forgives principal on a borrower’s mortgage, modifying the loan by reducing the amount owed, the bank receives a dollar-for-dollar credit, the report noted. In other words, for every dollar of principal forgiven in a modification, Credit Suisse receives at least $1 of credit toward the $2.8 billion in consumer relief.

But Credit Suisse can also earn more than $1 in credit when a loan modification satisfies certain other criteria.

Many troubled borrowers, especially those who bought their homes at the height of the real estate bubble, owe more on their mortgages than their properties are currently worth. Such borrowers are upside down on their mortgages; they have negative equity in their homes.

To help borrowers like these, the settlement assigns extra credit to Credit Suisse when it forgives enough principal on a loan to put the borrower in a positive equity position. The bank can earn additional credit up to $1.25 per dollar of forgiveness granted in certain cases.

The report is meaningful because it goes into scrupulous detail about how the Credit Suisse deal is working. This lets readers draw their own conclusions about how assiduously the settlement actually held the bank to account.

After the 2008 debacle, prosecutors have been criticized for failing to pursue criminal prosecutions of large and powerful financial institutions. In response, they have pointed to billion-dollar settlements with banks, like the one with Credit Suisse, as evidence that they are aggressive in their demands for accountability.

But letting a bank receive credit for principal forgiveness that others are actually providing is a flaw in this settlement. Allowing it to meet its obligations with actions it would have taken anyway is another lapse.

Credit Suisse is living up to the terms of the $5.28 billion settlement agreement. That’s to the good. But the nature of the agreement could have been stronger. And that’s too bad.